On Retirement

Delaying Social Security can outperform investment returns

But break-even period can be at least 20 years

Anyone with a passing knowledge of the time-value of money knows that $1 in hand today is worth more than $1 at some time in the future. Consequently, the incentive to invest today is based on the presumption of a larger payoff later.

One reader wrote to me recently vehemently arguing against the wisdom of delaying Social Security benefits based on lost-opportunity costs alone. Similar comments were posted in response to my Feb. 25 blog "Rate-of-return analysis shows value of delaying Social Security."

Someone whose full retirement age is 66 would collect just 75% of benefits if he claimed Social Security at the earliest retirement age of 62 versus 132% of benefits if he delayed until age 70 to collect the maximum amount. So if that person were entitled to a $1,000-per-month benefit at age 66, he would collect just $750 per month if he claimed Social Security at age 62, or $1,320 per month if he delayed claiming until 70. Deferring Social Security for eight years increases monthly benefits by 76%, plus annual cost of living adjustments.

CAN'T COLLECT FROM GRAVE

Of course, betting on increased benefits later also assumes you are more concerned about the longevity risk of outliving your money than the mortality risk of dying before you can collect benefits. Or, as I often tell my audiences, you must be present to win.

"Any retiree who fails to collect Social Security at 62 through age 69 must note the failure to collect as a debt on his annual statement of net worth," Steve Maersch, a retired journalist from Milwaukee and self-described numbers cruncher wrote in an e-mail. "The person who collects early gets full use of this money," he noted. "The person who waits until 70 to collect will get much larger checks, but must make up for the money he failed to collect ... In the vast majority of cases, he will come up a loser."

One of my favorite numbers crunchers, Michael Kitces, partner and director of research at Pinnacle Advisory Group, disagrees. In a blog posted last month, Mr. Kitces argued that delaying Social Security can be the best long-term investment or annuity that money can buy.

"The decision to delay Social Security isn't just about the value of delaying, but also about the money that must be spent from the portfolio to sustain spending in the meantime," Mr. Kitces said. "Yet a deeper look reveals that when viewed from an investment perspective, the decision to delay Social Security actually represents an astonishingly valuable 'investment' return, based on the internal rate of return of the cash flows that it provides over time."

Since benefits not paid from 62 to 70 represents forgone investment opportunity, Mr. Kitces said it is critical to account for inflation, which he assumes to be 3%, and a time-value-of-money factor, which he assumes is 6% based on a balanced portfolio rate of return.

Using those assumptions, he calculates it would take 22 years to recover from the decision to delay collecting $750 per month in Social Security benefits. But beyond 84, the decision to delay Social Security continues to accrue exponentially, not just in the form of the higher delayed benefits but continuing cost-of-living adjustments.

Mr. Kitces noted the break-even point is sensitive to the return assumption used — the higher the rate of return, the longer the break-even period. Conversely, with more conservative return assumptions, the break-even point is reached more quickly.

"Those who reach age 90 (which would be the 28th year after delaying) have generated the equivalent of a 5% real rate of return in what is essentially a government-backed bond," he wrote.

The payments produced by Social Security also dominate the nominal or real payments available from a comparable fixed or inflation-adjusted annuity, Mr. Kitces added. "This appears due primarily to the assumptions that are embedded in the Social Security formulas and benefits, many of which were built when longevity was shorter and interest rates were higher," he explained.

It is an even better deal for married couples because when survivor benefits are taken into account, Social Security essentially acts as a joint survivorship annuity payment.

FAR SUPERIOR

Mr. Kitces concluded that the decision to delay Social Security is far superior to any risk-adjusted returns that can be achieved over comparable periods by the available alternatives, including risk-free bonds, growth-oriented equities or annuities.

"Ultimately, the decision to delay Social Security delivers the best results when there is either unexpected inflation, unusually long longevity or especially bad market returns, which are the exact three scenarios that traditional portfolios are the least effective at managing," he wrote.

"Making the decision to delay Social Security," Mr. Kitces wrote, "is the ultimate form of 'anti-fragile' triple hedge."

Featured Video

Webcast

Faced with low yields, financial advisers have broadened allocations into a wide range of both equity and fixed income sectors. But will this shift toward greater risk and reward endure as the Fed and US economy normalize, or will investors return... Learn more